Conforming to portions of the Tax Cuts and Jobs Act, as outlined by California Gov. Gavin Newsom (D) in his fiscal 2020 budget proposal, could generate billions in revenue by the end of fiscal 2022.
According to state revenue estimates contained in a document by the Department of Finance provided by sources to Tax Notes, conformity with key TCJA provisions identified in Newsom’s budget proposal would generate roughly $1.4 billion in fiscal 2020, $1.04 billion in fiscal 2021, and $1.05 billion in fiscal 2022.
The greatest single increase in revenue to the state would be from conformity with the new limitation on business losses for noncorporate taxpayers in the TCJA. That provision would generate an additional $1.2 billion in fiscal 2020, and $850 million in fiscal 2021 and again in fiscal 2022, according to the state’s numbers, which were developed by the California Franchise Tax Board.
Conforming to new rules for small business accounting — including the provision allowing certain businesses to use the cash method of accounting instead of the accrual method when they have up to $25 million in average annual gross receipts over three years (as opposed to the previous $5 million limit) — would cost the state $220 million, $100 million, and $65 million in fiscal 2020, fiscal 2021, and fiscal 2022, respectively.
Conforming to new federal rules limiting like-kind exchanges would generate $260 million, $200 million, and $190 million, while adopting the new limits on business deductions for “fringe benefits” — such as entertainment — would boost state coffers by $200 million, $160 million, and $150 million in fiscal 2020, 2021, and 2022, respectively.
The governor’s budget would use much of the net revenue increase generated by conformity with specific TCJA provisions to expand California’s earned income tax credit program, with the state counting on roughly $1 billion in additional revenue from the conformity provisions identified in the budget proposal to fund a $600 million increase in EITC funding.
Additional conformity proposed by Newsom includes adopting the portion of the TCJA that creates Opportunity Zones intended to encourage business investment in poor areas, which would cost California a projected $37 million in fiscal 2020 and $70 million in each of the two following fiscal years.
Also examined was the cost of conforming to provisions that would allow greater contributions by taxpayers to Achieving a Better Life Experience (ABLE) accounts and the ability of taxpayers to roll over money from 529 accounts into ABLE accounts. Those proposals would each cost the state an estimated $0.4 million in fiscal 2021 and $0.2 million in fiscal 2022 — no cost was projected for the state in fiscal 2020.
According to the document, the proposals listed are for discussion purposes only and a final conformity package would “depend on input from the Legislature and the various stakeholders.”
The total revenue the state could see from the Tax Cuts and Jobs Act could be greater if other provisions are also adopted, according to Lenny Goldberg of the California Tax Reform Association. “There’s no reason to exclude corporate conformity on losses and interest as well,” which could generate substantial additional revenue, he told Tax Notes in an email.
Separately, Goldberg predicted the proposal to conform to the Opportunity Zones provision could generate opposition. “The federal benefits are so generous that state breaks would be excessive and completely wasteful,” he said.
Another critique of Newsom’s proposal comes from the state’s Legislative Analyst’s Office (LAO), which reviewed the governor’s conformity proposal. The LAO urged that the issue of conformity be considered on its own, rather than primarily as a means to fund the budget’s proposed EITC program expansion, warning that the state’s revenue projections could prove unreliable.
“Attempting to offset revenue losses from an expanded state EITC through a package of conformity actions would be problematic,” according to the LAO review. The cost of the EITC program could shift with the economy, while “revenues raised by conformity actions could change as taxpayers respond to any new incentives,” making it “difficult to craft a package of EITC and conformity changes that is revenue neutral.”